The 'Amazon Tax' War Escalates

Every consumer knows that shopping online can be a handy way to avoid paying sales tax on books, CDs and electronics. But not nearly as many know that they're still supposed to pay tax on these purchases. That's something Colorado, North Carolina and other states, desperate for revenue, want to change.

But by taking steps to collect what many have simply begun calling the "Amazon tax," the states have ignited a tax war with the huge online retailer that is the primary target of their efforts. In February, Colorado passed a law requiring Amazon.com and other Internet retailers to mail notices to customers reminding them of their tax liabilities. Amazon responded by shutting down its affiliate program in Colorado, effectively closing thousands of small businesses that were marketing Amazon's products over the Web.

Then, last week, Amazon sued North Carolina after the state's department of revenue asked the company to turn over the names and addresses of its North Carolina customers — information the state would need if it were to try to collect unpaid taxes. With as many as 15 more cash-strapped states weighing whether to pass Amazon taxes of their own, there's a lot of interest in seeing how that case, as well as a related case in New York State, turn out.

The disputes in Colorado and North Carolina are only the latest twists in the fight over Internet sales taxes. Opponents of taxing the sales of Amazon and other Web-based retailers say such measures are a misguided attempt at recouping additional revenue without having to raise taxes. Further, a Tax Foundation report released last month questioned how much money it would actually bring in. Still, the states say it's not just money they're after but fairness: Main Street retailers have to collect sales taxes, and leaving the Internet as a tax-free shopping zone puts them at a disadvantage.

The 'physical presence' test

While this has been an especially hot issue in the past few years, the debate goes back to 1992. That's when the U.S. Supreme Court said that states could not force retailers to collect taxes for them unless the retailers had a physical presence, or "nexus," in the state. The court's reasoning was simple. There are just too many states, counties and cities using too many different tax rates and rules to expect retailers to keep track of it all.

The case, called Quill v. North Dakota , involved a company that engaged in mail-order sales. But it underpins the taxation of e-commerce, as well. As online retail sales — and all the lost revenues associated with them — became too big for states to ignore, dozens of states set out to simplify their sales tax rules. By making it easier for companies to collect the tax, the states hoped, more retailers would be willing to do it for them. Some retailers, especially ones with a lot of physical outlets, such as Barnes & Noble and Target, agreed. Amazon did not. The company collects taxes only for Washington State and a few others where it has offices or some other physical presence.

In 2008, New York State tried a new approach. Amazon was doing a growing amount of business through its affiliates program, which pays people across the country to market Amazon goods on their own Web sites. The Legislature figured that because some of those affiliates are based in New York, the state could make a case that Amazon and other sites using the same business model, such as Overstock.com, had nexus there. The bill that Governor David Paterson signed into law was the first to be called an Amazon tax, although technically, it wasn't a new tax so much as an attempt to wring more revenue out of existing sales and use taxes. It worked: New York estimates that its law yielded $70 million in the 2009-10 fiscal year, from 30 Internet companies .

But Amazon also sued New York over its law, disputing that its affiliates amounted to a real physical presence in the state. A court ruled against the company, but it has appealed that decision.

In the meantime, Rhode Island and North Carolina followed New York's lead, passing similar laws saying that operating an Amazon-style affiliate program creates nexus in their states. This time, Amazon struck back in a different way: It simply shut down its affiliate programs there. While residents in both states still can buy goods from Amazon, Rhode Island has acknowledged that its Amazon tax has not produced any revenue . Frank T. Caprio, Rhode Island's treasurer and a candidate for governor, has called for repealing the law on the grounds that it's hurting the small businesses that used to rely on Amazon for their livelihoods.

By the time Colorado took up the issue in February, officials there had come to see New York's nexus approach as a dead end. Initially, they sought to mirror New York. But a House Finance Committee hearing in Denver saw an outpouring of protest by in-state affiliates. At the hearing, at least 20 participants in the Amazon program waited until almost midnight to voice their opposition, saying such a move — particularly if it caused Amazon to sever ties — would devastate their businesses. Lawmakers responded by trying something new.

The bill's in the mail

Rather than go after Amazon directly, they decided to educate consumers about their tax obligations when they shop online. The law , signed by Governor Bill Ritter, requires Amazon and others to mail yearly notices to their Colorado customers, telling them the total amount of purchases on which they still owe tax. (The same information is to be reported to the state department of revenue.) The notices are to be mailed by January 31, when taxpayers receive other important tax forms in the mail, and are to be sent in envelopes that say "Important Tax Document Enclosed."

"We just threw out the whole [New York] approach and said, 'What can we do to encourage compliance on the purchaser side?'" says Phil Horowitz, director of the state revenue department's office of tax policy analysis. We " were trying to figure out how to make it effective but still protect the affiliates."

Amazon didn't see it that way, and shut down its affiliate program in Colorado. "The regulations are burdensome," Amazon explained in an e-mail to the affiliates. Colorado's move is "clearly intended to increase the compliance burden to a point where online retailers will be induced to 'voluntarily' collect Colorado sales tax — a course we won't take."

North Carolina is the one state that is mixing both the New York and Colorado approaches to the Amazon tax. So far, it hasn't had much luck. Its law claiming that Amazon has nexus in North Carolina only resulted in Amazon shutting down the affiliates program there. More recently, the state's department of revenue asked Amazon to produce the names and addresses of North Carolina customers and the amount they've spent with Amazon going back to 2003. On April 20, Amazon sued the state, saying that the request would violate its customers' privacy. The case is to be heard in a federal court in Seattle, where Amazon is based.

Despite the legal squabbles in the states that have sought to recoup revenue from online sales and the strategies they've sought to employ, the varying types of laws and enforcement could have the unintended effect of forcing states and retailers to come together, says Harley Duncan, state and local tax managing director with KPMG's Washington National Tax practice.

Retailers will have to consider possible effects on their businesses from either turning over customer information or the burden of collecting tax dollars for the government. Meanwhile, states will have to weigh whether calculating and collecting specific tax bills from citizens is a worthwhile venture. " Maybe that loosens the gears a bit," Duncan says of discussions between two parties that have yet to see eye to eye on much of anything.

Indeed, Sujit CanagaRetna, senior fiscal analyst with the Southern Office of the Council of State Governments says with states' current budget crises, it's likely more will take aim at these largely untaxed transactions. Still, he says, the issue points to a larger flaw in the country's tax system — one that's still based on agriculture and manufacturing rather than services. " This is an issue that has to be dealt with, " he says. " Basically, to avoid running a 20th-century tax system in a 21st-century economy. "

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